May 24 (Bloomberg) -- Japanese Prime Minister Naoto Kan is
facing a backlash from ruling party lawmakers over plans to
raise taxes to pay for earthquake reconstruction, adding to
concern he will be unable to contain the world’s largest debt.

Kan will find it “difficult” to convince politicians in
his Democratic Party of Japan of the need for tax increases to
fund the rebuilding when the economy is shrinking, DPJ tax panel
head Sakihito Ozawa said in a May 20 interview. Ozawa instead
advocated bond sales and central bank purchases of debt -- steps
opposed by senior Cabinet members including the economy minister.

The lack of support underscored intra-party discord over
Kan’s leadership amid public criticism of his handling of the
March 11 record temblor that left about 24,000 people dead or
missing in northern Japan and triggered the worst nuclear crisis
in 25 years. His public support rating plunged to around 26
percent, less than half of the level after he became prime
minister last June, the Asahi newspaper reported last week.

“The DPJ was never really united from the beginning, but
when a disaster like this happens, the disunity becomes even
clearer,” said Hiroshi Miyazaki, chief economist at Shinkin
Asset Management Co. in Tokyo. “It’s reasonable for the
government to ask to raise taxes in this extreme circumstance
but it isn’t winning trust from the public” and “the public’s
concern is increasing day by day.”

Public Disapproval

Voters’ support for higher taxes to pay for reconstruction
has decreased in recent weeks, as the quake’s damage caused the
world’s third-largest economy to contract. Public broadcaster
NHK reported last week that 31 percent of those it surveyed
oppose higher levies, compared with 26 percent who support them,
whereas right after the quake supporters exceeded opponents.

The Nikkei 225 Stock Average, which has fallen 9 percent
since the disaster, dropped 0.1 percent at the noon recess today.
In a sign that fiscal worries haven’t weighed on the debt prices,
Japanese bond yields slid to near the year’s low as concern
about Europe’s sovereign debt crisis deepening boosted demand.

The nation’s economy slipped into a recession in the first
quarter, contracting at a sharper-than-expected 3.7 percent
annualized pace, as the quake interrupted production and dragged
down consumer spending, data released last week showed. The
government estimated that damage from the quake could be as much
as 25 trillion yen ($306 billion).

Moody’s Outlook

The GDP figures add urgency to “Kan’s plan to introduce a
second supplemental budget for reconstruction, which will likely
need to be much larger than the first one,” Thomas Byrne, a
senior vice president at Moody’s Investors Service, said in a
report. “However, Mr. Kan will need to overcome discord within
the ruling Democratic Party and gain cooperation from the
opposition Liberal Democratic Party.”

Moody’s cut its outlook for Japan’s Aa2 sovereign rating to
negative from stable in February on worries political gridlock
will prevent the Japanese government from reducing its deficits.
Japan’s public debt is about twice the size of its economy.

The nation’s net overseas assets declined 5.5 percent to
251.5 trillion yen last year, the first drop in two years, as
the yen’s appreciation cut the value of those holdings, the
Finance Ministry said today.

‘Sense of Crisis’

DPJ tax panel chief Ozawa said the government might need to
sell 20 trillion yen to 30 trillion yen of bonds for the quake
rebuilding, and that the BOJ should expand its debt purchases.

“There is no way that we can raise taxes when the economy
is shrinking,” Ozawa, 56, said in an interview in his office.
“The Bank of Japan should have a sense of crisis,” said Ozawa,
who is also a member of a group of DPJ lawmakers urging the
central bank to provide further stimulus to end deflation. The
DPJ anti-deflation group is opposed to tax increases.

Economy Minister Kaoru Yosano, who isn’t a DPJ member, said
this month that he “firmly” believes the central bank
shouldn’t directly buy debt from the government, and that the
bank has done the best it can after the disaster. Yosano said
last month that rebuilding funds “must be backed by taxes.”

After the quake, the BOJ pumped record amounts of cash into
the money market, doubled to 10 trillion yen a fund to buy
assets such as corporate debt, and began a 1 trillion lending
program to help quake-hit companies.

BOJ Governor Masaaki Shirakawa has said that bond
underwriting by the BOJ may hurt market confidence in the yen.

Leaving the DPJ

In the latest sign of party members’ discontent with Kan,
lawmaker Katsuhiko Yokokume is leaving the DPJ. Yokokume, 29,
had called on Kan to announce a second post-quake stimulus
package during the current Diet session that ends in late June.
He will call a press conference later today to announce the
decision, his secretary Yuko Makii said yesterday.

DPJ legislator Yozaburo Ishihara last month said Kan should
resign if the situation at the crippled Fukushima Dai-Ichi
nuclear plant north of Tokyo doesn’t improve, and other party
members expressed dissatisfaction with their leader.

A Bloomberg poll of investors this month showed Kan tied
with French President Nicolas Sarkozy as the world leader with
the least promising policies. Among Asian investors, 63 percent
were optimistic about Chinese President Hu Jintao, compared with
14 percent saying the same about Kan.

Almost two-thirds of respondents disapproved of Kan’s
response to the quake, according to last week’s Asahi survey.
The newspaper surveyed 1,996 people on May 14 and 15, and didn’t
provide a margin of error.

“Despite the critical situation, it is a ‘wonder’ that
discussions on economic and reconstruction policies in the
aftermath of the earthquake as well as on the sourcing of funds
have not made much progress and remain directionless,” Takuji
Aida, senior economist at UBS Securities Japan Ltd. in Tokyo,
said in a report. “Rather than being overly sensitive to public
opinion, we hope to see the ruling party either take political
leadership or show a greater commitment to work with the smaller
parties.”